Europe’s digital economy needs tax competition

Massimiliano Trovato and Diego Zuluaga

5 June 2014

How do you foster the emergence of a vibrant digital sector in Europe? This question has preoccupied policy-makers in Brussels for some time, so much so that in 2010 the European Commission created the post of Commissioner for the Digital Agenda, with the specific aim of putting digital technologies at the heart of the continent’s economy and to bridge the growing innovation gap between a thriving United States and an ailing Old World.

Unfortunately for the Commission, most of the factors driving entrepreneurship and innovation – whether digital or not – are beyond the control of even the most enlightened public officials. Where governments can and do have an impact, however, is in providing the right environment for entrepreneurs to take risks, for venture capitalists to invest, and for digital businesses to set up shop and hire. Particularly in the tax and regulatory arena, public policy can be liberating or stifling.

This reality was acknowledged by the Commission’s Expert Group on Taxation of the Digital Economy, which published its report last week. Encouragingly, the Group rejected the preposterous idea of a tax specifically aimed at digital businesses, which, quite apart from dealing a massive blow to Europe’s tech sector, would have raised serious concerns from the perspective of equality before the law. Indeed there are major difficulties with the very idea of reforming international taxation to target a particular industry, let alone specific companies within that industry.

(These issues did not prevent the Italian government from passing legislation requiring companies to only buy online advertising from providers with an Italian VAT registration – effectively a tax on search engines. To the relief of budding techies in Milan and Turin, the measure was later cancelled.)

Where the experts deserve less praise, however, is in their attitude to corporate taxes and the direction that EU policy should take in this regard. While conceding that corporation tax policy involves ‘a difficult trade-off between collecting […] tax revenues […] and establishing a[n] […] environment that fosters investment and growth’, the Group went on to endorse the work of the Organisation for Economic Cooperation and Development, which in its 2013 Action Plan on Base Erosion and Profit Shifting called for greater international coordination on tax policy and an end to ‘unfair’ competition between tax jurisdictions.

There is nothing wrong with countries learning from one another and working multilaterally to develop best practice. But the mention of ‘coordination’, especially in the context of the European Union, inevitably brings up the spectre of ‘harmonisation’ or, more bluntly, ‘equalisation’. This need not imply a single, common tax rate for all European corporations. Indeed, the Commission’s proposal for a Common Consolidated Corporate Tax Base – which would allocate a predefined share of a company’s income to each member state where that company operated, to be taxed at the national tax rate – and the equally misguided suggestion of a ‘destination-based’ corporate tax – i.e. levying taxes not where production takes place, but where consumption happens – are much more sophisticated than that.

Yet at their core, whether wittingly or unwittingly, they achieve the same thing: to mitigate countries’ ability to attract investment by lowering the tax burden on businesses. Both proposals imply that a company operating in both Ireland and France, but headquartered in the former, would no longer pay all taxes on its income at the very competitive Irish rate of 12.5%, but would see a large chunk of it confiscated at the much less attractive French rate of 33.3%. This would not only harm Ireland and the company in question – it would also hurt workers and consumers in France, Ireland and the rest of the world.

Why? Because when you reduce a country’s incentive to keep taxes low, you encourage it to become less like Ireland and more like France. And even a superficial comparison of the former – which hosts the European headquarters of several leading tech companies including Apple, eBay and Facebook – with the latter – where entrepreneurs in 2012 rose up to protest President Hollande’s hikes on already punitive business levies – shows that a shift in France’s direction can be no good thing for innovation and digital entrepreneurship.

The crucial point here is that, in tax policy as much as in the private sector, competition is hugely beneficial to consumers, workers and taxpayers. Not only does it contain the growth of the state and encourage governments to spend more wisely – it also fosters an environment where people are more likely to invest, take risks and innovate. And the benefits of tax competition are not limited to those living in low-tax jurisdictions: French consumers have access to the same high-tech goods as their American and Irish counterparts (albeit perhaps at a higher price). The benefits of entrepreneurship spill over into even those places that discourage it.

Of course, it may (and should) be debated whether traditional tax schemes ought to be adjusted to the new reality of a digital economy, which enables production to move freely across jurisdictions in order to take advantage of the most favourable environment. But any changes to the basic structures of international taxation would have to apply across industry boundaries: to search engines as well as to cheese-makers, to digital products as well as to furniture.

So the nature of the issue calls for a much broader discussion than the one we are having. In the meantime, if the European Commission wants to begin to bridge the digital gap between Europe and America, it should work to retain Ireland’s ability to show France how a country can attract a burgeoning tech sector.

The expert group on taxing the digital economy steered away from a specific tax on digital businesses but they did rubberstamp the new 2015 EU VAT rules. Indeed they see these new rules as the template for a
global tax on the digital economy.

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